Summary

Between all the elements in trading that traders focus on and can focus on, risk management is often overlooked and under appreciated.
Today I bring on Michael Toma, who has a long history as risk manager and a trader, to talk to us about not only the importance of risk management but how risk management has to do with a lot more than just stop management and loss reduction.

Mike has a great way of bridging the topic of risk and helping traders understand the applicability of risk management not only to our trading but to the sustainability of your trading business.

Michael Toma, CRM, is a frequent speaker of the Trader Expo circuit and is the author of The Risk of Trading: Mastering the Most Important Element in Financial Speculation (2012) and Trading with Confluence: A Risk-Based Approach to Trading Equity Index Futures (2010). His unique “focus on the risk” approach to trading using data-driven risk analytics has attracted professionals seeking improvement in their trading performance as well as new traders seeking a consistent and transparent approach to the markets. Mr. Toma also received the Certified Risk Manager (CRM) designation for risk management excellence from the National Alliance in 2007. In addition to his experience as a corporate risk specialist, he actively trades the US-based equity index and index futures markets as well as the equity markets in mainland China.

[00:14] Houston: Yeah, absolutely. Mike is actually the author of a great book called The Risk of Trading: Mastering The Most Important Element in Financial Speculation and we are going to talk a lot about that book, but a lot about his other ideas as well because I am sure Mike has a lot of stuff to share with us, because he has been trading around the business for a long, long time so I am very excited to get deeper into his story. Before we begin though, Mike can you just tell us a little bit about yourself, tell us about your trading background and maybe just kind of what you doing today?

[04:27] Mike: Sure, I got started way back in ’98 – it seems like yesterday. I was one of the ([04:33]) era guys who came out of there and to be honest I had no clue what I was doing, but I was fascinating about the lights and everything like you hear a lot about today, but I really realize very quickly that there was a core element of my background in my corporate world which was risk management and process improvement that I felt like I can bring to this business and at first in I actually broke even and those commissions where pretty high back then in the late 90s, so for breaking even the first time I was frustrated, but I felt like I can do something with this. So I went back to corporate life and continued on my risk management journey, mostly with financial institutions and insurance companies, but then the burning edge came back and I decide I need to give this really a full time go and then I really never looked back, I am sure we will talk about, yeah obviously we are going to talk about risk management in our discussion, but really how some of the corporate risk philosophies that you see in corporate America really can be applied to the trading world and specifically for traders trying to get to that next level.

[04:38] Houston: Yeah, we’ll definitely talk about that topic, because it is funny, risk management is sort of the redhead step child of the trading game, it is not sexy sizzly part that everyone wants to talk about you know, everyone want to talk about setups and indicators and you know holy grails, so before we get any deeper – why don’t we first kind of define for the audience, what is risk management? Most of us when we talk about risk management we think of stop losses or maybe some sort of loss reduction strategy, but give us a broader swath around what risk management really is?

[05:09] Mike: Sure, sure and it is probably one of the most and I say this a risk professional, probably one of the most boringest topics or questions one can ask in a seminar, but I will put it in a perspective that will again help traders. Risk management is a concept, or first let’s define what risk is you know, we’ll look at that and a lot of traders will say well that’s, how much I can lose on a trade or something like that, but really looking at the core concept of risk, it’s really simply a chance of loss of anything, alright the chance of losing something. That could be money, it could be opportunity, it could be time alright, but in the trading world I like to re-define it as any outcome that is different from an intended result – it’s obviously on a trade or on a trading program; you want to have winning trades well obviously if that doesn’t happen or at least consistently doesn’t happen, that would be a result that was I guess unintended, so when we talk about risk, let’s think of it from that trader’s perspective. We wanted to do something and we walked out, it look like it was sunny, we didn’t bring an umbrella and next you know it is raining over our heads so how do we do that. Risk management really is the concept of protecting assets okay and again, thinking like trader or in the trading business, we’re trying to manage our assets so we could take advantage of an intended result, obviously a winning trade, successful trading strategies things like that. So, really in summary not to get too winded on this somewhat dry topic, but what do our assets say we got to look at what is a trader’s asset? Well, capital is obviously a key asset that we want to again protect, but what are some of the other things you know, look beyond that. How about keeping the trader solvent okay, you know once the bank roll goes that’s it – games over; so really a key risk management element that I want to see traders engage in is what are we going to do to keep you solvent. Let’s put aside the strategies, let’s put aside I got the Holy Grail. What is going to keep you solvent to get you to trade another day, OK? You know, for those traders maybe looking at something, maybe a little different path – let’s say their goal is to work for a hedge fund or some manage other people’s money. Well, one of the risk components that you want to consider is keeping a compliant track record, because that is something that you can do everything in the world to have 100% success in winning trade and never have a losing trade, but if you took all these wild risks and leverage down and all these things, a hedge fund will just throw you out the door, so look at what we are trying to protect and obviously for most traders you know, they are going to say capital and that is fine we will go with that.

[08:47] Houston: Yeah and you know your book – let’s talk it up for a second, because I really enjoyed your book The Risk of Trading; most people like you said they think that the topic is dry but when you actually begin to see the applicability of risk management to various elements of your business, that’s when the light really popped on for me; so if I was going to read the book, because I thought oh maybe it is going to give me some interesting ideas around you know stock management and how I can manage my trades better, but, then you get in some deeper errors like how you make sure the business remains solvent, so as an individual trader, you need to think about not just your trading strategies, but how do you actually maintain that business for the long run. But I really think you break it down well in what you call the phases of risk management or the process of that; can you talk through that sequence you talk about risk identification, risk assessment, maybe just talk us through those four phases?

[09:07] Mike: Sure and again just to your point. In fact I was listening to one of your prior podcasts about having fun in this business you know, I think it is very essential I mean, if you are not getting engaged over winning trades and good solid execution of trading and being successful – you need to get out of the business – cause this can be a very excited business, but like any business you know, there are some core fundamental things that have to be taken care of so to speak and, risk management is one of them and I would think obviously, the most essential part of it, but going back to your question about the phases of risk management and again we will take it out of sort of the corporate world, but again they apply directly to trading. The first one is identification: so what we want to do is really identify opportunity okay – where and again going back to risk – identify opportunity where these positive outcomes can come about. What are the components that need to be done to identify those potential optimal situations? We also want to identify what are areas of concern or weaknesses are okay and we will talk about probably later on in our session about developmental opportunities and how we can come better traders, but we want to identify those where the point, because if we don’t address those they will come back to haunt us in our ultimate goal. Continuing the next part of risk management is, once we have identified what our potential exposures are we want to assess them okay; if, thinking back say in the corporate world, if you manage say a supply room and you found that there was a pencil missing every month or so –well, technically there could be a situation there, but really the risk is so minimal that we are not gonna worry about it. So assessment is looking at really severity. What are the big problems I need to be concerned about? What is that black swan that again is going to affect my goal? Is it a pencil in the supply room? No, but is it blowing my account? These are the things that we really want to focus on particularly early into a trader’s career okay, then once we assess those, what do we do to control that okay? So in the trading world we can do a lot of things when we see an opportunity in a trade, we can avoid it, because we just know all the things don’t match that we are looking to do. It sounds easy, but a lot of people just – risk avoidance is just a very challenging thing to overcome, they feel like they always have to be in the game. Prevention – which is reducing frequencies of losses okay even though they are small we want to reduce the frequency. We also want to reduce severity okay again, so we are going to reduce the amount of losses, we are also going to reduce the big one okay and that can be challenged particularly in the options world, where you can have really successful options traders who are maybe right 20% of the time; again these principles are core risk principles, but they can be argued in certain arenas and then there is also technical methods that we use and then again the traditional thing like stock managements for trades or in a case of the trader business, which you will hear me talk a lot about that. The business of trading, let’s not focus on individual trades. What are you business controls? Do you have an alternative location where you can trade if you know, there is a power failure? What about multiple accounts to spread your capital in case there is problem with the broker, not just your money, but maybe just their platforms are not executing right are there is a problem you can switch over, it keeps you in the business, maybe when you are first trading that’s not too important you just close it out for the day. For me, I am accountable for that on a daily basis and the last part of risk management process is really measuring and monitoring – another key element; so we have identified areas that we should be concerned about, we’ve assessed the severity that hey this could be a big problem, we put in action to minimize those exposures such as controls and now we are going to measure and monitor what those controls to see, hey is it impacting our bottom line, is it helping me improve to reach my goal as a trader and those can be we look and say lessons learned, how do we improve our process or refine our strategies, do we have action plans that we say, okay we have identified this problem, now what are we going to do about it. Well a lot of people will say I need help in this area and they do nothing about it. What do you do in a professional business environment? You set action plans and you say I am going to find the solution, I am going to get the right person to help me with this and they are going to do it. In the trading business it is the same way and when we create things like development plans where we put all these things together and say look how am I going to grow in this business and what I like to do is and I encourage everyone to actually document it, report it just like you are an employee in a large company.

[14:35] Houston: And we will definitely talk about that topic of development, because that is also an area I love to think about and speak about, because I don’t think like what you said, most people probably don’t spend enough time thinking about how they are going to grill themselves or improve themselves to meet some of their long term goals, but taking a step back for a second – so I think you know, what you said there is very powerful and the idea being a lot of times I see a lot of traders they just think that all of their problems will go away if they can just make more money right, if they can just get that next trade and make that a winning trade, where you seem like you are kind of saying that when I have heard you talk before, some of the lower hanging fruit is around maybe losing less money right or making less mistakes and reducing the frequency in which you know you’re taking some unnecessary losses.

[14:28] Mike: Oh great, totally great and you know this, we are really focused on the money and you know, we are guilty of that; I still am guilty of that, but at the end of the day good trading strategies or compliance, risk compliances, doesn’t pay the mortgage you know, it is the P &L, but really like any business, I mean I will give you an example. When my wife comes home at night, I don’t say how much money did you make today from work? Well I kind of know it is pretty much a set thing, but I don’t ask her that, so why do people ask traders that you know and why do traders ask themselves that? The question should be, how was your day, were you compliant with your business plan? Right and again easier said than done, this is not easy, if it was easy everyone would be doing this, but taking the focus off money and you have heard this a lot and it is tough to do. There are controls again let’s get back to risk management, risk controls, maybe taking P& L off your dome, off your tracker – there are little things that you can do to help that, but I think it is more of a mental thing that the focus needs to be on business plan execution and everything else will take care of itself.

[15:38] Houston: And if you can find joy in that and fun in that and being able to follow your plan and that if you are able to do that across five days or two weeks or the whole month, if you are able to make that a joy in itself, then the money will come if you can follow your trade plan assuming you have the right positive expectancy in your trading system, but I firmly believe that. I’ve heard you said it before like why don’t the pros measure their performance in dollars and cents so you just kind of talked about it already, but maybe you rift on that for a second.

[17:08] Mike: Yes, think about it ask you know, as an employee in a company okay and I still do risk consulting work in addition to my trading just to keep me in that mind set, where you know, trading has this, what are the benefit or you look in an article benefits of trading, because you know, you are your own boss. Well guess what, one of the biggest concerns about this business is, you’re your own boss, so you know when you are on assignment say in a company and a lot of traders you know, work on the side or they trade on the side and they have jobs. Your bosses they are not looking for what was your core results, maybe in sales there may have been, but even in sales let’s do it. Obviously you want to make more sales and generate more money for the firm and probably for yourself, but really what are the things that your sales manager is going to be asking you. How many appointments do you have this week? Did you distribute some many brochures? They’re looking at metrics that has nothing to do with, did you sell this guy? And again for certain industries it leans more towards that, but they’re looking at core decisions or core actions that they know will lead to a certain result and particularly in like say in project management or things like that or you know, the project manager is not going to ask you, you know, did you get the results yet? What they’re gonna say is: are you following the steps that I put in my plan for you to do that? And really like a trader they should think about it like they are in this business if they are going to follow the plan, I’m gonna get rewarded and probably get promoted and if I’m not my boss is probably gonna let me go and the problem with trading is that at the end of the day if you don’t follow your plan, you don’t let go – just the next morning you just put on a different shirt and say hey I’m still with the company and that’s the sort of challenge I think that individual traders have. Look at it as if there was a boss overhanging you and saying this is easy, just execute – execute this plan, don’t worry about failure – in fact if you fail, I’ll still keep you.

[19:15] Houston: Cause then you see the data, you can actually see where you made some mistakes and of course correct them if you need to versus just kind of….yeah, free-forming it or free-wheeling it.

[19:24] Mike: Right, right and so we’re measuring as trader community or at least, we’re measuring the wrong stuff – we’re measuring P & L and I know it sound like a broken record but a lot of pros say this but I just can’t pound it more and I’m guilty. I’m guilty too, I do look at it sometimes during the day but again just focusing on the job at hand will get you to the next level.

[19:47] Houston: So do you think it’s better to focus on, instead of like P & L, like you said I guess focus on trade plan compliance or maybe the way your managing your risks so you know counting R’s – risk to rewards ratios versus actual dollars and cents. Do you think that’s preferable, or is it just all about trade plan compliance; what’s your thought on that?

[20:08] Mike: I think the above are pretty good, anything other than P & L and honestly P & L can be a very valuable metric; I mean at some point it has to be. But what I look at is – I would suggest develop sort of key metrics particularly around compliance; Im a risk compliance guy so I’m gonna promote this part of but there are other elements but since Im the specialist on this area I’ll focus on that. Rather than focus on P& L and again keep it within a trading world – where was my entry? Like I’m a big ([20:49]) in risk management you can identify risk control and other areas but what can you control during a trade? A lot of it is just the entry – I can control when I’m gonna get in, I can control my targets and stuff but really once I’m in it’s kinda up to the trading gods to get their variances do their thing and hopefully I have a historically edge based on historical trades when these things set up then X will happen 60, 70% of the time.

[21:17] Mike: But focus on, was my entry appropriate? Did I use a data driven indicator or something to say yes this is when I was supposed to execute; because a lot of times the difference between a winning trade and a break even and sometimes even a losing trade is where do they get in and again you can measure that through measuring your trade activity. One of the other compliance you could look at too is when percentage win or points gained on a winning trade versus points gained on a losing trade so winning versus losing sometimes can keep you askew because strictly in options on certain futures, if you’re taking smaller profits on winning trades and letting losers go longer you can have a positive winning percentage but you can be down. When I do trade journal audits or I encourage traders to look at their information – that’s one of the key ones I look at – what is your winning trade gain versus your losing? It doesn’t necessarily have to be 5: 1 or 3:1; options traders can have a negative number but what it does is again identifies – first step in the risk management process – it identifies that maybe you’re taking your profits too early and maybe you’re giving your losers a little too much time to run.

[22:47] Houston: Yeah and we’ll talk more about the trade journal in a second because I think that is such a – you have some very good ideas around that. But maybe I could circle back for a second and just ask you one question around something you kinda brought up already; so I’ve heard you say in the past that traders should perhaps think of themselves as project managers as it relates to managing risks. So, why is that? Why do you think they should take that PM approach versus, I’m just a trader so I should shoot what moves?

[23:18] Mike: Yeah, well to be honest – in my experience some of the traders that I’ve worked with – once you bring the emotion into the trading, you start thinking that the market is gonna do this – the success rate just goes down. So project management is a very defined, documented plan; what it requires is the premise of a project is again doing your due diligence like a Project manager would do so if we do this, if we execute properly the assumption is that based on our history it will come out to meet our expectation. So I think the focus for a lot of traders is on their opinion about the markets and I gotta tell you – I’ve been doing this Houston for fifteen, seventeen years – when I base my trades on where I think the market’s going, I’ve tops 50% – tops. So, there have been studies about market randomness and things where really it’s just in a sense a 50/50 game and at the end of the day you could use risk management to push your edge from a 50/50 game to 55 or something but you have to be perfect in execution but I found that it just doesn’t really work too much so as a Project Manager, really what is our goal if again you’re in a company , your boss says OK we’ve got this project- what is he basically saying? Execute the plan, so if we focus less on the world of trading, all the flashy lights and the price movements and things like that; this is what I’m supposed to be doing, this is my job, Im a Project Manager and as a matter of fact fire yourself as a trader, you’re not. You’re now officially a project manager starting today and my job is simple. It’s a one sentence job description – execute this plan.

[25:16] Houston: I love it. And so what do you then, I know you work with a lot of traders – does this approach work for everybody cause I could see some traders they may feel like they’re getting handcuffed being they like being discretionary, do you find that there are certain personalities accepting this kind of approach? Or do you have to be more conservative – or maybe that’s not the right word – but I guess more critical thinking versus more discretionary, is there any validity around that?

[25:56] Mike: Oh, I agree, yeah and there’s a lot and I guess a lot of the great guests you’ve had in your podcasts talk about the psychological aspect of trading and so on but that isn’t my specialty but clearly there’s an element to that; ([22:25]Houston: Right) this is where the nice Mike Toma gets to be a little more strict as far as teacher/student: I’ll just say it like this – my mentor told me this: treat this business correctly ‘cause you’re a little bug trying to eat a crumb and there’s a big monster trying to push you aside so you know, he’ll let you take crumbs but if you take on the monster you’re gonna get crushed. ([22:54]Houston: Right) So here’s my response and I’ll just say this directly and we’re trying to help traders here – if you don’t like taking the disciplined, focused approach on how to be successful, get out of this business; there are so many distractions with trading that and it allows you to provide a market opinion and all this and you have winning trades and you brag to your friends that you’re the greatest trader in the world and everything but, you know if you’re not gonna be disciplined and follow a strategic plan and again, not just project management and stuff – I know that’s my philosophy and having a structure at least that you’re gonna follow and I’ve told people this – I think it’s just time you get outta this business. If you want to just throw money away, do something good with it or something or get outta this. I kinda try to shock them in that sense but at the same time what I’m trying to do is fill some type of structure and I will say this – I’ve learnt, you do get people like I know in the back of my head, I wanna give them the opportunity but I don’t know if they have the mindset because a lot of people just don’t know how to follow rules. Now I will say this – you know who else didn’t know how to follow rules? Bill Gates, Steve Jobs – there are some great entrepreneurs who – and I would also encourage them to, you know what, don’t get out of this business but stopping being a trader and start building really good technology for our industry and they’ll probably have a much bigger house than I’ll ever have so yeah, this business kind of allows a ticket to the show if you have bank roll and unfortunately there’s no vetting process, I mean there’s no interview in a sense the interview is – I have capital. But to be successful, there’s a very, very heavy, very strict interview process that needs to be done and unfortunately it needs to be done with your self. ([24:58]Houston: Right) Sometimes people take it the right way and sometimes people just pay the price – the tuition- through P&L.

[28:52] Houston: So true, because like you said, the bar to entry is low but the bar for success is high so certainly you get all types of individuals and maybe like you said the mavericks out there who have the kind of shoot from the hip approach to life, they struggle a little bit more because they have less structure or they’re less willing to adopt structure but for folks you know if they could just see in the beginning that they need a bit of structure that would also help their journey quite a bit ‘cause I think a lot of people try to figure out on their own and –I’m guilty of this – for many of my earlier years just trying to figure out on my own and just kind of getting lost in a quagmire and not getting or understanding how to get out of it; ‘cause I wasn’t doing the fundamentals like journaling and putting the systems in place so that I understand where I was making mistakes and where I was making the same mistakes over and over and over again.

[29:48] Mike: Touché, what we’re doing Houston is we’re fighting a human element; outside of this person is not fit for this, we’re fighting a human element – that human element of “I don’t want to touch the stove, it’s too hot, but I know I’m gonna touch the stove ‘cause I’ve gotta find out if it’s hot”. And the market kind of just finds a way to make sure they expose every little piece of challenge that we have and we have to almost re-wire our thinking and I know that’s very business psychology and stuff but I used to laugh at that stuff when people used to tell me but you have to re-wire your thinking; look, dude just show me the set-ups, you know but ten years later I’m saying we have to re-wire our thinking – we’ve all paid the price that way so…

[30:35] Houston: Yeah, so let’s talk a little bit more about the trade plan, so I think you’ve pointed out in other places that even though everyone’s has heard about the trade plan and following it; at least 80% of traders don’t have a defined trade plan but if you do have a trade plan and you are diligent about defining that and trying to follow it, it’s still sometimes difficult to remain in compliance with that trade plan and I know myself, I know my goals for this year – you know, I’ve been trying to be compliant as possible around my set-ups and so on and so forth but even just being compliant sometimes is difficult for many reasons such as like you said, not having the right level of focus and maybe not being able to be at the trade desk at the right time of the day and you know just getting pulled off on different things. So, what’s your advice around traders who have that trade plan in place but are having a difficult time with tracking that or managing that, what are your ideas?

[31:38] Mike: Well, there’s ways to track it and there’s key metrics that we talk about and you know certain things as the win to loss ratio or the points gain/points loss but I relay like to look at internal compliance and the few things that I would recommend that traders who are struggling or who just want to improve their game is to take that independence away from the trader’s sort of beauty about the trading business – you’re a freer, independent person – take it away and put it in the negative column, so the first thing I would suggest is, you don’t have a boss in this business, find a boss – find a boss that has the authority to make you accountable OK. And I’ll even go one further, and that could be a fellow trader – your group s great ‘cause you have fellow traders within the same community and some which certain skill sets and some which maybe are struggling and you can kinda cross match them to put the ones with the strengths, with the person who has the weakness; to have a fellow trader, a mentor, risk professionals but even worse dare I say it, your spouse. The worst accountable person that you could deal with but I think it’s good to get them involved or a partner – so find a boss that has the authority to make you accountable ‘cause once you have to report what you’re doing and the areas that your weakest in, there tends to be a sense of urgency to get it resolved, especially if there’s an incentive for both parties and I’ll even go one step further and I’ll suggest this – have that accountable person dare I say – have the ability to turn off your account ([29:33]Houston: Wow) when certain metrics or certain compliance – certain rules in your trading plan are not being met. You wanna talk about urgency and how quick you’re gonna do whatever you can to make sure; it’s tough to do that on your own because to be accountable to yourself is just difficult; so one –find the boss and, the second thing I would recommend and these are good takeaways that you could communicate to other traders is: try trading – this is why you’re trading for the day; try trading, try using internal indicators only. So take away the chart, OK ‘cause it’s really just an attractive mechanism to want you to get in there and trade and it lures you and things like that; and most of the time, even if you get into the day, you get in at a bad price or you end up chasing the person you wanna dance with and the next thing you know it just doesn’t work out. So try trading using internal indicators and that might seem fine in the beginning but it’s very different and very freaky because you’re in the back of your head saying “what’s the price at now?” But try doing that and when you go through workshops, try to get the traders to say OK, push the button; and I’m a big New York Stock Exchange tech fan – to me that’s like my number one internal indicator as far as entry so I’m just gonna push the sell button when it’s at a high extreme and sell it back when it’s at a low extreme, things like that but again it gets you in the mindset of execution and execution by using data driven technical information – not price. So whether it’s New York Stock Exchange tip or market profile value – whatever it is –and that’s part of the development phase; try doing that ‘cause what you’re doing is coding your mindset to stop thinking about there’s a pull back in price – price is the worst indicator – use internal indicators, again that have been successful’ or at least give a historical edge say okay, I may be wrong on this but I’m getting in at the price which not only is historically advantageous is also compliant with my plan. And again, my only focus with that – if I fail, I’m okay with ‘cause I’ve complied with my plan.

[35:43] Houston: What a great day and that’s a really great tip; I’m definitely going to try that Mike; that sounds really interesting.

[35:48] Mike: It will drive you crazy in the first day – it’s just bizarre. It’s kinda like walking blindfolded like you’re trying – don’t worry about it. I’ve actually – what I do to bring it to the next level is: if you have it on try to keep – you know when a target has been hit, you have a little sound indicator or a stop – put the entry and then all you see is your internal indicator and the sound so, if you hit your target, you heard the sound and it’s like wow, that’s interesting. Si I did that without looking at price and I have to tell you – a lot of time my charts – I mean it’s on but I’m really not looking at it because the indicator is gonna drive me to what I’m supposed to be doing anyway.

[36:28] Houston: That’s a really good, a good exercise I think on many levels because like you said number one – you have to re-wire your brain and if you do that pattern enough times you’re gonna get into execution mode, right? You’re not gonna worry about, “oh my these prices are acting funny”; you’re gonna stop looking at that as being kind of a trigger for you to do maybe non-compliant things and the other part I love talking about is that price action is off like you’ve already talked about there – it just throws out so many social signals, right so when price moves in a certain way and they’re backed up by volume and pace I think psychologically as human beings we can see that as human behaviour and that triggers something in us – that could trigger fear, that could trigger some sort of emotion and it causes us to do some potentially – it causes to make some potentially poor choices – so actually removing price action completely is a fascinating idea; I’ll definitely try that.

[37:23] Mike: Yeah, it’s not easy and again business isn’t easy and people say well, I’m just gonna trade or I like when the green turns red or whatever it is; this business is not easy so you have to kind of do things maybe not so outside the box but to in a certain way take you away from the things that are distractions and price is one of the biggest distractions – price and P&L are probably the two biggest distractions in this business.

[37:48] Houston: Yeah, that’s a good one. Let’s talk a little bit more about compliance issues and so for instance we have all been told that we need to log all our trades in a journal; so what about the trades that you fail to execute on, that you fail to take – how do you track those types of phantom trades?

[38:03] Mike: Yeah, I think it’s important because when we have and I encourage people to have a trade journal and put the valid information in there – not just price and what you did but really just the internals or the things that drove you to make that decision around your trading plan – the internal indicator or whatever it was that triggered it but what I find is most trade journals are basically a snapshot of what you executed and for whatever reason – and they could be all legitimate reasons – there are a lot of times opportunities you just didn’t take and I call them like you said phantom trades but they were valid signals, valid indicators that were triggered based on a historical positive edge blah, blah, blah that weren’t taken. Well, why are those not included in the assessment to see if the set-up, the strategy is valid or whatever. They’re just as valid and in fact a lot of time when I do trade journal audits, I look at a trader and say why didn’t you take these and they’ll say “oh I lost three in a row or the market was tanking or why would I go long or sometimes maybe a legitimate thing – I’m guilty of that too – well I was up for the day and there was maybe an hour left in the trading day and I wanted to protect my green. Maybe all three are valid but the phantom trades when you log them are gonna say and this actually an example that I had earlier in my career I said “you know I wanna protect my green too” but this baby is cranking out 72% success rate between the last hour and fifteen minutes of trading; I mean I wanna protect my green too but I also wanna increase my opportunity so by documenting phantom trades they bring out – again risk identification – they identify opportunities to say “hey, maybe I need to look to look at this some more, maybe I need to make a change to my plan or things like that so, really what are phantom trades? They are exactly the same thing as executed trades except you didn’t push the button. Well, the market gods really don’t care if you push the button or not and it allows also to give you a greater sample size to determine really strength and validity of a particular set up so again, I try to encourage a lot of traders to do that, I know a lot of the scalpers who have 30, 50 trades a day will get a little crazy but I guess the takeaway here is, don’t just think the ones you push the button on are the ones you’re gonna base your entire trading plan on ‘cause let’s face it when you push the button maybe you’re pushing the button incorrectly or not the right price or maybe it’s just not part of your plan. So there’s a ton of information in these “phantom trades “and again a little outside the box but I encourage everyone to at least think about that.

[41:00] Houston: So tactically, would you just put phantom trades as another entry in your journal log as a trade entry or just comment that it wasn’t actually taken that it was just a phantom trade and you just put just them side by side or you just keep them in a separate journal saying I miss these five trades for these particular reasons?

[41:16] Mike: Sure, put them right in the same trade journal and really just make – if you’re using a spreadsheet – try to keep it simple but for most traders when they use the spreadsheet there’s an indicator like “A” for actual and “P” for phantom so you can sort it and if you do actual versus phantom, you may be surprised that “wait a second, say there’s a particular set up that you’re tracking in one category – if you have multiple categories of set ups – you say okay, this is set up number one.” Interesting, my success rate on actual executed trades is say 58% and I say okay that’s good and I have good P & L or whatever it is but my phantom ones are 67% ([38:13]Houston: right), why is that? I don’t know but you know what you did – you just started the first step in the risk management process – you’ve just identified something where you say “I need to look into this, I need to what? Do the next steps – assess, control, measure, monitor – so I think it’s valid information and you know what maybe some of the information that comes out of that is nothing. So what is that telling you? You know what I’m executing my plan –if it aint broke don’t fix it, I just gonna stick with it.

[42:27] Houston: Right, and so do you have any thoughts around who should trade journal and I know you’ve worked with retail traders as well as traders in the hedge fund world; do traders from all levels benefit from the trade journal? ‘Cause I hear of some traders that have been trading for a while and they say I don’t need the trade journal anymore – I did it for many years and now I’m done with it. What’s your opinion about all that?

[42:48] Mike: Yeah, I think there is such thing as the best surgeon in the world but I guarantee you if he is the best surgeon in the world, he’s probably thinking “I know I can do better.” Now when you’re in the hedge fund world trading other people’s money, there’s a risk manager in that firm saying “I don’t care what you say, I know “; there’s always something, always a method to improvement. One of the things about trade journals though – and I would encourage everyone to have some type of not just the documentation – but some type of data that provides analysis and the good thing about technology when I first started out, the technology was the spreadsheet but now you can just push a button and it generates all the stops for you and sort it any way you want and different audiences may be different. Hedge may have a risk manager – if you’re your own trader you the audience, you are the accountable person but one of the things I think it will also help if you’re not specifically inclined to think that you’re able to improve; it also may be able to sort of fine tune what areas of the day that you have the most impact on or what’s the most ([44:01]); so some traders just have interesting lifestyles and they look , you know I can make 90% of my profits in this hour and a half according to my documentation and you know, I’ll do other things or whatever the case or they’re really focused in on this time of the day cause that’s when they’re really …so they can kind of have the screen on but maybe do other things. It’s just that there are a lot of things that can come out of it but I find it very difficult to think that it’s an investment in time and effort that would pay off – particularly for younger traders.

[44:35] Houston: Yeah, and it really just kinda layers into what you’ve written in your book about having that data driven approach to risk management and trading ; so what do you think should be in a good journal, aside from your standard profits and how much you won or lost and when you took it. What else should be captured in a good trade journal?

[44:56] Mike: Yeah, I mean those things never stop people from doing those elements; honestly P& L, I really don’t wanna see it, I usually just hide that column ‘cause again if I’m trying to develop traders and even myself that’s a very poor indicator. In fact when I see too many big winning trades in a row, there’s always that variance where you’re in the zone but that concerns me to an extent; to me that’s a red flag – like what are you doing there?

[45:26] Mike: And also, maybe you got those high profits because you’re taking more risk than you should and that will be eventually the big reversion to the mean or the big reversion to insolvency; but one of the things that I would like to see traders add on there – and again it sounds like a broken record – was I complying with the trade? Okay, so trade compliance and I wanna see once you have a trader that’s really trying to catch on to this dynamic to add to their trading arsenal, you really wanna see 92,95, 97% trade compliance , okay. When you start to see that look at that as a sort of promotion or reward for you; I’m not sure if I discussed this – I think maybe it’s in the book I made mention of it- but reward yourself, not for P&L but for trade compliance; you can take – I take a futures rollover day which is tomorrow by the way – I take that day off ‘cause if I’m compliant with my plans – like a reward for myself and after certain other things I’ll take trips and things like that and I put pressure on myself to say okay I wanna go to this expo or something and you know what in two months I’ve gotta earn that. And plan compliance tracked through your trade journal is a great way to say “I’m on the right track”; it also identifies areas that, you know what there are so many things here that I have to measure to be compliant – maybe I have too many things I’m measuring or, it identifies a core problem that we really wanna resolve before you sort of promote yourself for graduating to higher trading contracts and things like that.

[47:13] Houston: Yeah, I think that what you’ve talked about there – having numerous characters and sticks in order to ensure compliance, it makes sure you’re having a bit of fun but giving yourself some rewards for enjoying the process but also I love the idea of maybe outsourcing some of the compliance – getting you to comply with your trade plan by pushing it, outsourcing to an external party. I love that idea but talk about the graduation plan – you just name dropped it there so, I think the idea there in your book, you talked about using a framework around when to add size to your trades. We have a number of wins; we have the gut feel that we want to add size but the graduation plan when I read about that, I’m like this is a great kinda structure way to kinda layer into growing the size of that set up so talk to us – talk us through that?

[48:18]Mike: Sure, it’s without doubt the most popular topic after I speak in seminars or you know people talk about the book; you know they all lean towards this graduation plan and it’s so simple and it’s a simple concept and I’ll explain it to you. Really, it’s one of those things I didn’t think would get much traction but it’s very effective. What it basically is: and I will keep this simple as possible okay. It is a risk management methodology that basically what reveals with size of your trades, whether it’s shares or if you are trading stock or a future contract and things like that. The whole concept is when you are learning or trying to execute a strategy that you are just getting familiar with, let your results dictate the amount of quantity of contracts or shares that you are trading. One of the question says how many contracts have you trade or how many shares do you trade? This is one method in which you never have to answer that question, because it is already going to be dictated to you by this plan, so simple enough you start a new trading strategy or you heard it from a friend, oh this is the holy grail, great I am going to look at this and I am going to try and set up my charts or whatever and do what I got to do. You start out at the minimum level or even I would suggest even simulation, right. Let the strategy dictate if it is working well you want to, look at these strategies as your employees, okay we are going back to the business mind set. These are your employees; I have say 10 strategies so 10 employees. One of them is just out of the gate just going crazy, it is just very consistent, a couple stumbles here and there, I am going to promote that guy right. How do you promote yourself your strategies and trading? You increase your size okay, what am I going to do with the ones that are struggling, well I am either going to kind of work with them or try and figure out what it is ([50:20]) or I may just get rid of them alright and I may just end up with three good employees that are just all secretaries, just constantly cranking out good results. This is my business and that is what I want, successful strategies and I am going to get rid of the ones that don’t, but it is also going to identify maybe the strategy is obviously working for this other person I read in a book or a seminar or you know a webinar. Maybe I am just not executing it properly and I have had that and Houston, I am sure you did, some good strategies and I see people use it; and I am just like you know what, Mike I don’t get that market profile thing, well you know what, I do, but that is okay take it out of your plan, take it out of your arsenal, it is kind of weird with those little pointing figure letters and stuff and some people just don’t like it, that fine. So not only do I identify ones that are successful for you, but I also identify ones that maybe you just have trouble executing, but you are doing it at such a low risk level financially that you can afford to kind of pay the price or if you are in sim you know sometimes new strategy that you have may never get out of the sim level, because it hasn’t had the results to do that, well no harm no loss you know, so what I like to do is throw things in the hopper, because we are always inundated with the latest and greatest new strategies and all these things and I know a lot of educators will say, that’s all crap and this is the only way to do it. No I say, you are a business man, you are a business person, go for it, throw it into your graduation plan and let your results dictate, should you promote them or fire them and a lot of times these strategies they just don’t work, sometimes just little nuances where one maybe element of the strategy looks very interesting and then you incorporate that into another one of your successful ones and that’s how you develop not only as a trader, but you develop your business as a trader.

[52:16] Houston: Right, so well put. I really like that exercise, it really builds like you said some confidence around your setups, because it allows you to add size responsibly and for the ones that aren’t working right, you pull them out and get them back into the sim mode where you kinda revamp and get back to it again so that is a great, great tactical tool.

[52:44] Mike: Yeah, how many traders have blown up because they blew their accounts? Well you know, the graduation plan concept isn’t going to solve all the problems, but it will definitely, you cannot go insolvent, you cannot blow up your account if you use the graduation plan, so it is not the holy grail for everything , but at least it will keep you solvent and in this game you know, your capital is king, so if you keep your solvent, sometimes it will buy you time so the graduation plan is one of the biggest facets to it is it buys you time during the development phase to where you can kind of learn your strengths and weaknesses and make your mistakes at a very cheap level.

[53:18] Houston: Yeah and if you are a new trader and you know you are inundated with strategies like Michael said and you have like a dozen strategies or a dozen step-ups, then you know this is a perfect way to begin to properly test these things out, so you need to figure out which ones are the set ups you really want to invest in, put money behind and let the ones that don’t work so well, let them kind of slowly get off of that graduation plan, so I can’t agree with that approach more than that.

[53:48] Houston: Yeah, and do you have any opinions about you know, in terms of just sample size when you’re doing – just to go back to trade journals for a second – do you have an opinion, do you need to have 30 or 50 or 100 trades before you can do some proper metrics on your trade journal?

[54:04] Mike: Yeah. I mean it is a fair question you know, I revert to more traditional accounting sample sizes and things like that, but to be honest with you I mean if your set up doesn’t occur like every day, after about 30 seem to be that like agreed upon number where you can say okay, this is probably working and you are going to have days where the randomness of the markets aren’t working, but to go from like 30 successful outcomes to 30 negative ones, it is going to be difficult I mean things should be consistently you know, improving and maybe just a little pull back, so 30 is a good number if you are actively trading you know, 75, a 100 you know, there is some strategies that they say with variance you are looking at like 1100 and I put in the book; some say 1170 something I go you know, by the time you figure it out, you’re been foreclosed on your house, but yeah and I use like and again to promote yourself I use a variance of about 30 or so and there is things like standard deviations and normalizations stuff which again, I don’t like to get the new trader too involved in that, but when you promote yourself you can use like a plus 15 something like that, but if you have had a net success of 15 trades, you could promote yourself at that level and again you are not betting the ranch, you are going to say a level two and by the way if you find a level two, this isn’t happening, you are going to revert yourself back to a level one. Because a lot of times what that tells me is strategy is working, but now scarcity is coming to play ([55:48]), but you know what, if you eventually keep doing you will and maybe there is again risk control techniques, maybe systematically executing your trades to get rid of the emotion, but that is a good problem to have you know what I mean. I will be honest with you. I still at some point especially with these markets of late, I am at levels where I had to pull back, the heck with the graduation plan, this is just too much for me, so you just make good business decision.

[55:14] Houston: And so when you are talking about jumping from level one to level two, is that kind of coincide with let’s say jumping from like a risk in 1% of portfolio per trade to 2%, is that the kind of idea you talking about there or adding contract sizes from, 5 contracts to 10 contracts, is that what you are talking about?

[52:49]Mike:Yeah, I’m looking at size, you’re obviously risking more dollars, but the thinking is you should have more dollars in your account at that point, so eventually in this business use I mean, you have to and it is a tough thing, once you become very well successful at a certain strategy or two, if you really want to make it in this business you really have to start increasing size and that is an additional challenge, beyond charts, beyond risk management, those are behavioral things that really come into play. You talk about some of the traders in the Chicago pits when they were around and some of the hedge funds ones, they still struggle with it, the only difference is hedge fund firms can have professionals and they do have professional psychologists on staff to work these traders through this thing and basically what they are doing is they are working them through the graduation plan. I am sure they are using much fancier systems, but I have actually worked with psychologists who had high wealth clientele, who to get them to the next level, because it is a struggle but believe me that is a good problem to have and obviously when you are at that level, even going from level one to level two or even sim to level one – you know congratulate yourself, reward yourself because that’s not easy and rather than think this is a burden, I get excited; I say I got an employee now, not only is it historically valid data, but I am able to execute it and both have to work in order to promote yourself.

[58:12] Houston: Yeah and that just increases your confidence and that just becomes a virtual cycle so yeah that is well said.

[58:17] Mike: And honestly one of the risk is, I find it is too much sometimes like you wanna hold on let the system work for you and patience is – don’t give up – so you’ve rewarded yourself and as soon as you reward yourself, I know risk managers always have like this – what’s the problem, they always look at the negative thing, but you just rewarded yourself, but you know what, you just inherited, now all of a sudden it is like a bull in a China shop, it is like relax and stick to the plan. And a new set of identified risks now come into play so…

[58:51] Houston: And so with the time remaining that we have, can we just touch on development because we just were talking about investing in your mindset and doing some development around your psychology but everyone’s heard of having a trade plan but I don’t think everyone’s kind of formalised a development plan for themselves so what are your thoughts first off on mentorship and coaching where do you place that on the spectrum of development?

[59:14] Mike: Sure, I think it’s an essential part. You’re right, very few people, even trading coaches don’t really talk about a development plan per say it’s more about focusing on their weaknesses and a development plan is a part of that, but again let’s go back to the corporate world when I’m reviewing an employee or a boss was reviewing me – they’d have that annual review or semi-annual review – one of the things is well okay these are the things you did well, these are the things I want you to work on but really if you want to develop with this company and get to that next level not necessarily in your job, it maybe in another department or something these are the core skills I want you to work on so they’d give you a little development plan and you’d do it and take your classes and well, again taking that concept into the trading world it’s very effective. So realistically what I’d like traders to consider is the first thing to do is called a SWOT analysis. It’s very popular in the corporate world in employee development and training. It’s basically a SWOT is identifying your strengths, weaknesses, opportunities and strengths so and again not necessarily particularly on trading strategies but also your business as a trader. For example: I’m great with identifying trades but I’m a little slow in pushing the buttons I get scared; especially if it’s like a reversion to the mean trade where the market is tanking and I’m supposed to be going on. Let’s identify part of the risk managing process, opportunities and weaknesses obviously you wanna identify those. Threats also are something I would say well what’s a threat? A threat is anything that can force you to be outside, to have to give up this business so the threat is too much size, printing too much money to risk one of the things I found when I work with traders is one of the biggest threats in their business- believe it or not is their spouse or partner- and it has nothing to do with trading but why do I have to get out of this business well my spouse says I have to get a real job or they gave me so much time and I just couldn’t get the hang of it or they just don’t get it. So there’s a way to do that you know engage them in it, let them be your accountable person, show them that this is kind of a commission sales job like I’m not gonna come home with a pay cheque every day but I’m gonna get there. So these threats and I think it’s maybe critical for the trading mentorship community but they need to look at these things. It’s not just about you’re not hitting the set up correctly it’s about what are all the thing that are going to be a potential threat to your business and if one of them is that, I mean I’ve been around tables where I’ve sat with a trader and their spouse and they say okay I need you to walk away I need to talk to them alone and the spouse will walk back like n-n-n-n-no I need the trader to walk away; I want to talk to them how do you feel? Are you concerned about this? And they go yeah so I just kind of engage them and say look this is a journey and some of the things you need to do to support your partner – so again it’s something that you wouldn’t think would be in a trade development thing but I think Houston, with these discussions, our discussion today all the people who have been a part of your community these are some the things that they will listen to this and say you know what that quirky guy from Jersey had a good point- I’m gonna try that. And if one or two people try it , it kinda catches on and not everything is gonna be used by everybody that we talked about but again just getting back to summarize with the development plan and identifying the weaknesses, strengths. So looking at consistency, success and failure; I don’t look at loosing trades as failure – failure is defined as not executing a plan effectively. So if I’m losing trade I have no problem with that if I’m compliant even it’s 5, 7 in a row ([63:02]Houston: It has nothing to do with you). The market is its own little monster and I’m facing historic probabilities and I know that there is gonna be certain variances and things like that that I can’t control but what I can control if I execute that I’m compliant and that’s fine with me so consistency, execution- dare I say the word discipline – so in your development plan identify all these and again you can do with an accountable person. But the most important thing is throughout this concept of this development of this – action plans- when you identify these things have an action plan for each one and say I’m going to work on this and within a certain time frame and then report my development at a certain day. I talk about some examples in the book and everything like that, but it’s really important again these are the things that the average trader probably won’t do because they either think it’s a waste of time or just it’s too tedious but again if u start thinking about your trading as a business this – every corporate business has some type of development plan – so why are we not doing this in ours.

[01:04:18] Mike: That’s’ a great question. Keep an open mind to education, there’s a lot more education out there than when I started so, use that power to learn, educate; also educate yourself and really start taking action in trading. I mean back testing is great but start pushing the button and again use the graduation plan do it in sim, learn at a very cheap price but you really need to take action and you know reading books is great but you learn by doing in anything in life so do that and the other thing too is again discipline, structure is one word that really encompasses our whole risk discussion today it’s about structure but the thing too is: don’t do this alone this is a business where the beauty is you can do it alone but I’m begging everyone don’t do it alone. The other thing too is in this community is that there’s so many people who love to teach, love to help and to pay it forward so take advantage of that it’s one of the things I didn’t do in the beginning is that I kind of a hermit, so take advantage of that and learn from other people’s mistakes and again the concept I’m talking about here is not just about trading it’s really about success in business and in life don’t be afraid to ask and raise your hand. Use the power of information that is so accessible now, much more than when I started to develop and just remember one thing is in this business it looks so easy but it’s not; it’s just like going to medical school, I mean you really have to put your time into it and the ones that are successful and the ones are not it all comes down to, of all the things we talked about, who’s gonna put the time in and when I see people you know they recommend books and can I have books you recommend and I’ll give them some sort a core non-risk books to start with and a few months later they’re excited about it and say what you think? I’m on chapter 2 and then they see other traders who are just like the next day they’re through 2 or 4 books and reading on the internet more about it and you can tell the engagement level is different. So it’s like everything – it’s not about trading -it’s just think like a business person about what it needs to be successful and execute and if you don’t it’s ok, there’s other things in life but for us I think this is the best business in the world and it just takes a lot a work and those who are willing to do it get rewarded.

[01:07:07] Houston: Yeah, it’s like you said the exceptional performers out there it’s not what they can do, it’s what they will do – so that’s well put. So let me just one more quick question for you. Tell me about yourself; you’ve been trading since ’98 if you went back 20 years ago had the opportunity to give the younger Mike Toma some advise what would you tell that person around his trading journey?

[01:07:30] Mike: Well, I think one of the deficiencies is that the information just wasn’t there so you had to rely on people so that was something I was just faced with but again I would have definitely been more open join more groups and bounce ideas things like that. I had the drive and ambition so I wasn’t so like I was there Saturday morning looking at charts.

[01:07:55] Mike: So it wasn’t a question about that. We’re motivated either by inspiration or desperation and probably a little combination of both; but I think the focus and I’ve learnt the hard way and when I talk about these principles they weren’t just like from day one “oh these are great”, I had to learn the hard way and realise that I need to work on my core and if I had to do it over again I would’ve start not with trading strategies but learning core principles about how to be successful in this business and then take it from there and how many times do just the opposite I mean I speak at seminars and you do all these things about risk and you always get the guy who comes up I just wanna get a set up and I kinda chuckle you know what that was me way back when so develop from the ground up like any business. I mean you have a restaurant you don’t open on day one with no spoons and forks and no place to serve you get the space, you paint it nice and pretty you learn how the business works and then you sort of promote, advertise, get people in and provide great service. You just don’t sit there and say food is here today; so yeah it’s a business plan and the one thing I would have done a little bit better is to treat it more like a business cause I was lured by the lights and things like that.

[01:09:25] Mike: Yeah, so some of the stuff isn’t very flashy in a sense but it’s good business practice and so you save your flash for buying nice beach houses and stuff when you reach your target.

[01:09:37] Houston: Great advice. So what a great conversation today thank you so much Mike. Just the last question: what’s the best place people can stay contact with you, if they love your ideas and they wanna follow you and engage with you further, where can they find you?

[01:09:50] Mike: Well, I tell you one of the things I don’t do per say is – I don’t have like a trading school or anything like that I’m very selective on when I can go mentor traders things like that but to reach out just go to the money show websites I do a lot of work with them in education, you can find me there I think there would be an avenue through your group as well, I’d be happy to do that but one of the things I sort of – there was a time when I did a lot a promotions and it’s great but I’m very sort of at a state in my career and life where I’m just content of doing what I can do and if anybody has any questions that’s fine. I try not to go out there and market myself maybe in the future though that’ll change I don’t know, but they can just go through those different avenues again, I do a lot a speaking at the traders expo so they can go over to that site and reach me and I’d be happy to answer any questions they might have.

[01:10:51] Houston: Sounds good. And I’m so happy that you had the chance to connect with us today and talk to us and give us so many tips and ideas. So for the audience, as I just said Mike gave us a bunch of great ideas today some really good tactics, some really good lessons so what’s the one biggest insight you got from this podcast? Let me know – spend some time and listen to the podcast and let me know – what would you be willing to commit to trying? There are so many good ideas here so like Mike earlier pick one thing that you heard today and just try that for the next 30 days and see if that makes a difference in trading. If it works for you, let us know I’d like to hear from you in the show notes and as usual you can find the show notes, a transcript of today’s podcast and as well as other resources we’ve mentioned today on our website and that’s at the tradingedge.org\episode9. That’s it for the show today, thank you so much Mike I had a great time.

[01:11:44] Mike: Oh, I had a great time and thank you Houston and best of luck to your trading community.

ABOUT ME

My name is Houston Truong. I'm full-time independent North American equities, options, and cryptocurrency trader and have been trading for the past for 12 years. I coach traders around the world about the intersection between trading, peak performance, and psychology. I am also the founder of the Montreal Traders Meetup group.